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175 Years of Financial Risks and Returns in Central Banking

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175 Years of Financial Risks and Returns in Central Banking A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Abildgren, Kim Working Paper 175 years of financial risks and returns in central banking Danmarks Nationalbank Working Papers, No. 103 Provided in Cooperation with: Danmarks Nationalbank, Copenhagen Suggested Citation: Abildgren, Kim (2016) : 175 years of financial risks and returns in central banking, Danmarks Nationalbank Working Papers, No. 103, Danmarks Nationalbank, Copenhagen This Version is available at: http://hdl.handle.net/10419/171797 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu January 2016 | No. 103 175 YEARS OF FINANCIAL RISKS AND RETURNS IN CENTRAL BANKING Kim Abildgren Danmarks Nationalbank The Working Papers of Danmarks Nationalbank describe research and development, often still ongoing, as a contribution to the professional debate. The viewpoints and conclusions stated are the responsibility of the individual contributors, and do not necessarily reflect the views of Danmarks Nationalbank. As a general rule, Working Papers are not translated, but are available in the original language used by the contributor. Danmarks Nationalbank's Working Papers are published in PDF format at www.nationalbanken.dk. A free electronic subscription is also available at this Web site. The subscriber receives an e-mail notification whenever a new Working Paper is published. Please direct any enquiries to Danmarks Nationalbank, Communications, Havnegade 5, DK-1093 Copenhagen K Denmark E-mail: [email protected] Text may be copied from this publication provided that Danmarks Nationalbank is specifically stated as the source. Changes to or misrepresentation of the content are not permitted. Nationalbankens Working Papers beskriver forsknings- og udviklingsarbejde, ofte af foreløbig karakter, med henblik på at bidrage til en faglig debat. Synspunkter og konklusioner står for forfatternes regning og er derfor ikke nødvendigvis udtryk for Nationalbankens holdninger. Working Papers vil som regel ikke blive oversat, men vil kun foreligge på det sprog, forfatterne har brugt. Danmarks Nationalbanks Working Papers er tilgængelige på www.nationalbanken.dk i pdf-format. På hjemmesiden er det muligt at oprette et gratis elektronisk abonnement, der leverer en e-mail notifikation ved enhver udgivelse af et Working Paper. Henvendelser kan rettes til: Danmarks Nationalbank, Kommunikation, Havnegade 5, 1093 København K. E-mail: [email protected] Det er tilladt at kopiere fra Nationalbankens Working Papers forudsat, at Danmarks Nationalbank udtrykkeligt anføres som kilde. Det er ikke tilladt at ændre eller forvanske indholdet. ISSN (online) 1602-1193 175 YEARS OF FINANCIAL RISKS AND RETURNS IN CENTRAL BANKING Contact for this working paper: Kim Abildgren Danmarks Nationalbank [email protected] RESUME Afkast og risiko ved centralbankvirksomhed gennem 175 år Centralbankerne rundt omkring i verden har betydelige indenlandske og udenlandske finansielle aktiver og passiver på deres balance, hvilket afspejler deres rolle som pengepolitiske myndigheder. Dette papir belyser de langsigtede tendenser i risiko og afkast ved centralbank- virksomhed med Danmarks Nationalbank som eksempel. Papiret præsenterer nye årlige tidsrækkedata for Nationalbankens balance og finansielle resultat 1839-2014 og analyserer udviklingen i basisindtjeningen og indtjeningen fra yderligere risikotagning inden for en simpel aktiv/passiv ramme. Gennem de seneste godt 175 år har basisindtjeningen forbundet med de funktioner og risici, som uundgåeligt følger af at være centralbank, gennemsnitligt set tegnet sig for hovedparten af Nationalbankens finansielle resultat. Siden begyndelsen af 1980'erne har der dog været en nedadgående tendens i basisindtjeningen i takt med det generelle fald i renteniveauet. I denne periode har indtjeningen fra yderligere risiko taget som en finansiel virksomhed ud fra en afvejning af forventet afkast versus risiko bidraget væsentligt til det finansielle resultat. Papiret bidrager til litteraturen med et langsigtet historisk perspektiv, som gør det muligt at belyse det potentielle samspil mellem de makroøkonomiske vilkår, den pengepolitiske strategi og finansielle risici og afkast ved centralbankvirksomhed. ABSTRACT 175 years of financial risks and returns in central banking Central banks around the world have substantial domestic and foreign financial assets and liabilities on their balance sheets reflecting their role as monetary authorities. This paper explores the long-term trends in risk and return in central banking using the central bank of Denmark, Danmarks Nationalbank, as a case study. The paper presents new annual time series data on Danmarks Nationalbank's balance sheets and profit from financial items 1839-2014 and analyses developments in core earnings and earnings from assuming additional risks within a simple asset/liability framework. During the past 175 years or so core earnings associated with the basic functions and the risks that unavoidable follow from being a central bank have on average accounted for the main part of the Nationalbank's financial return. There has, however, been a downward trend in core earnings since the early 1980s in step with the general decline in the interest-rate level. During this period earnings from additional risks taken as a financial institution by evaluating the expected risk-return trade-off have contributed significantly to the financial return. The paper adds to the literature by taking a long-term historical perspective that makes it possible to trace potential links between the macroeconomic environment, the monetary-policy strategy and financial risks and returns in central banking. KEY WORDS Central banking. Risk management. Accounting. FX reserves. Monetary history. JEL CLASSIFICATION E42. E51. E52. E58. F33. G11. N23. N24. ACKNOWLEDGEMENTS The author wishes to thank colleagues from Danmarks Nationalbank for useful comments on earlier drafts of this paper. The paper is solely based on information, which is within the public domain. Views and conclusions expressed in this paper are those of the author and do not necessarily represent those of Danmarks Nationalbank. The author alone is responsible for any remaining errors and shortcomings. 175 Years of Financial Risks and Returns in Central Banking by Kim Abildgren January 2016 Table of contents 1. Introduction......................................................................................................................... 3 2. A brief review of related literature...................................................................................... 3 3. Data on Danmarks Nationalbank's balance sheets and financial returns............................ 5 4. Risk exposures .................................................................................................................... 5 5. Financial return and risk management.............................................................................. 12 6. Core earnings and earnings from assuming additional risks............................................. 18 7. Final remarks .................................................................................................................... 22 References............................................................................................................................. 23 Appendix:Danmarks Nationalbank's balance sheets and financial returns 1839-2014 – Data sources and compilation issues........................................................................................ 27 A.1. Balance sheets............................................................................................................... 27 A.2. Profit from financial items ............................................................................................ 33 2 1. Introduction Central banks around the world have substantial domestic and foreign financial assets and liabilities on their balance sheets reflecting their role as monetary authorities. As a consequence, they are exposed to a variety of financial risks that also have a huge impact on the financial returns in their income statements (i.e. profit and loss accounts). Due to policy constraints derived from their overall objectives – which typically are centred around price stability and financial stability (Reis, 2013) – central banks differ from private investors, and the risk-management methodologies and
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